Want to clean up the environment? Make credit easier to get.

Prof. Ross Levine has found a new way to encourage businesses to be environmentally friendly: Make it easier for them to borrow.

Research by Levine, the Willis H. Booth Chair in Banking and Finance, is the first to show that when lending conditions ease, businesses invest more in projects to cut pollution. In a new paper published by the National Bureau of Economic Research (NBER), “Bank Liquidity, Credit Supply, and the Environment,” Levine and co-authors from two Hong Kong universities conclude that easier borrowing promotes environmental responsibility in two ways: First, as the supply of credit rises, loans to finance environmental projects become more readily available. Second, as interest rates drop, lower financing costs boost the payoff from green investments.

Professor Ross Levine

“Changes in credit conditions have an impact on the environment,” Levine says. “When a company can borrow more than it could in the past and interest rates fall, the company is more likely to invest in reducing pollution.”

While these expenditures help the environment, companies are not going green merely for the sake of the environment. These investments offer real benefits to the businesses themselves, slashing the fines they pay for pollution, improving the health and productivity of their workers, and burnishing their public reputation.

Surprising results

The link between credit and the environment is largely unexplored territory in the academic literature, exemplifying Levine’s talent for uncovering economic and social connections that are important but not obvious. For example, he has previously studied links between banking deregulation and income inequality.

In his latest work, Levine says he was surprised that easier credit led to more environmental spending because he had assumed business investments in green projects were largely dictated by legal requirements. “I would have bet heavily that firms only invested in pollution abatement in a manner that satisfied minimum regulatory requirements,” he stresses.

Fracking windfalls provide test case

The NBER paper, written jointly with Chen Lin and Zigan Wang of the University of Hong Kong, and Wensi Xie of Chinese University of Hong Kong, investigates how a sudden increase in the amount of money banks have available for lending affects the environmental performance of their business customers. The authors used an ingenious method to isolate the effects of credit: They examined what happened to the environment when banks got a windfall in lendable funds because of the fracking boom.

Fracking developed explosively starting in the early 2000s as the technology to extract natural gas from shale deposits became economically viable. Energy companies began buying mineral leases from landowners in shale areas, and the landowners in turn deposited some of those payments in local banks. This surge of funds rapidly expanded the amount of money those banks had to lend. To see what effect this increase in bank deposits had on the environment, Levine and his co-authors looked at emissions of benzene—a widely used industrial chemical present in exhaust from many industries—and other pollutants in selected counties where banks receiving fracking money were active. They excluded counties where fracking was taking place to avoid having their results affected by economic changes due to gas production itself. Instead, they studied counties that weren’t producing gas, but had branches of banks that received a fracking windfall elsewhere.

The results were dramatic. Benzene levels fell 26 percent in non-gas-producing counties that had the biggest gains in credit availability—due to their banks receiving deposit windfalls in other counties—compared with benzene level changes in the average county. Other toxic pollutants showed similar declines. “After controlling for many factors and influences, including industrial and economic activity in the county, we observe sharp reductions in air pollution in those … non-shale counties,” Levine noted. The authors attribute the environmental improvements to easier credit terms.

EPA records show lower toxic emissions

The authors also analyzed the environmental performance of individual companies that got better credit terms because of the fracking bonanza. They used data on large syndicated loans to identify companies whose main lender recorded a bump in deposits because of shale gas production. The researchers then checked the Environmental Protection Agency records on these borrowers and found they reduced toxic emissions more than similar companies whose main lender did not get a shale windfall. These companies also received higher performance ratings from environmental groups and spoke out more forcefully in public on green issues than the control group.

Levine cautions that his research draws no conclusions about the environmental effects of fracking itself, which has been linked with a range of problems including groundwater contamination, release of greenhouse gases, and greater earthquake risk. Rather, he and his coauthors use fracking as a way to study the effect of easier credit on the environment.

The research on credit and the environment fits in with Levine’s broad interest in the social effects of financial regulation and credit. As a follow-up, he says he wants to explore how borrowing conditions influence worker safety.